ECO100: LECTURE #13
Firm’s SS Curve is Firm’s MC Curve (if P > AVC)
MR = P
MR = MC q* is profit-maximizing level of output.
Question: Is firm earning economic profits?
To Answer: add ATC schedule compare P to ATC
LEVEL OF PROFITS
TR > TC profits TR /Q > TC/Q P > ATC
TR = TC breakeven P = ATC
TR < TC loss P < ATC
Case 1: Economic Profit (P > ATC)
25 MR = P
10 q Profit-maximizing output: 10 (P = MC)
Profit: (P – ATC) * q = (25 -20) * 10 = 50
Case 3: Economic Loss (P < ATC)
25 MR = P
Economic Profit: (P – ATC) * q
(25 – 30) * 10 = -50
The firm cannot choose to change its price to $30 b/c it faces a perfectly elastic supply curve
At P = 25, firm produces q = 10
Case 1) Implies that P > AVC since firm chooses to produce output rather than shut down.
Case 2) Equivalently, economic loss > 50 if firm shut down.
EXAMPLE: HOT DOG STANDS
The market for hot dog stands is perfectly competitive.
The typical hot dog stand is earning economic profits.
1) What will happen to the market price of hot dogs?
2) What will happen to the number of hot dog stands?
Perfect competition characterized by freedom of entry; entrepreneurs are constantly seeking economic opportunities.
Economic profits new firms enter SS shifts to right market price falls
(new firms enter)
When will price stop falling?
Answer: when economic profits are zero and there is no incentive for firms to enter (or leave) the industry
LONG RUN EQUILIBRIUM